Keeping it in the family
Rob St George discusses the pros and cons of family-owned and controlled businesses
Rob St George is a freelance journalist. He was formerly senior reporter for Citywire Wealth Manager and deputy editor of What Investment.
Some of the very largest companies in today’s stock markets – such as Alphabet, Facebook and Alibaba – are still owned or controlled largely by their founding families. But recent interest has focused most often, as have recent discussions of most things, on the Trump Organization.
How well family business and global politics will mesh remains unknown for now, but investors in a previous Trump venture will be well aware of the challenges of combining a family business and minority shareholders. Trump Hotels & Casino Resorts floated publicly in 1995 and was bankrupt less than a decade later1.
Such experiences are a useful corrective to any tendencies to romanticise family-owned businesses: the conflicts of interest between controlling founders and minority investors can undermine the benefits typically ascribed to such corporations.
That is not to say that those benefits are not real, however. Chief among them can be a longer-term vision for the company from the family and a greater commitment from management to delivering that vision. Family-owned businesses, whose owners are more interested in sustaining the business and growing it over the generations, are less likely to be as focused on short-term earnings than other companies.
Because of this longer-term focus, they may be more inclined to invest in future growth, even at the expense of current dividends and earnings figures. In addition, there can be an element of personal attachment, especially where the founder is still involved in the business, although there can of course be a danger that the founder becomes blind to the needs of the business as times change.
The debate need not be entirely theoretical, either: there are plenty of listed businesses in which founders and their family have retained large stakes and seats on the board. Their financial performance is published across a wide range of metrics, so it is possible to investigate whether the advantages of family ownership outweigh the risks for private investors.
A host of studies have tackled this question, and the consensus is that family-controlled businesses do in fact tend to reward external investors.
Cristina Cruz Serrano and Laura Nuñez Letamendia of the IE Business School, for example, looked at almost 2,500 European stocks between 2001 and 2010.
They found that family businesses – defined as those in which an individual or family holds at least 20 per cent of the company’s shares and at least one family member was a board director – generated a compound annual return of 13.6 per cent over that period, significantly ahead of the 8.6 per cent from non-family businesses2.
"In all the countries examined, family firms achieved much higher returns than local indexes did at similar or even lower risk levels,’" stated Cruz Serrano and Nuñez Letamendia. "The study findings leave no room for doubt: listed European family businesses created more value for their shareholders during the period 2001-2010. When controlled for other factors that might affect value creation in all its aspects, such as size, debt level, risk and sectoral distribution, these results clearly point to the existence of a family effect which has a positive impact on creating long-term value for shareholders in the case of listed European companies."
Separate research has identified a similar effect in US equities, with the important caveat that minority investors are protected against family owners using tools such as non-voting share classes to restrict oversight3.
We looked across business cycles from 1997 to 2009, we found that the average long-term financial performance was higher for family businesses.
In emerging markets, Glen Finegan, Head of Emerging Market Equities at Henderson, is cautious about investing in companies where there may be a potential conflict between what is in the interests of minority shareholders and other controlling parties, such as the Chinese government. Instead, he and his colleagues look for companies with long-term owners whose wealth is invested in the same class of equity as third-party investors.
"In the developing world, these kinds of companies tend to be family controlled groups," says Finegan. "In this situation it is possible for us to take a view on a family's ethical values, wheras it is more problematic with state-owned corporations."
When investing, he and his team look at how the family has historically treated its minority shareholders, as well as at other businesses owned by the same family elsewhere, to establish that there are not any conflicts of interest. Among other factors, they also look at whether there are independent board members, and the company’s attitude towards risk.
In fact, attitude towards risk appears to be an important factor in the long-term success of family-owned companies. Nicolas Kachaner and George Stalk of Boston Consulting Group, with Alain Bloch of HEC Paris and Sophie Mignon of the École Polytechnique, have highlighted the defensive characteristics of family-owned businesses.
Analysing 149 publicly traded, family-controlled businesses in Europe and North America with revenues of more than $1 billion, they reported that these firms were less leveraged than their non-family peers: from 2001 to 2009 debt accounted for 37 per cent of their capital, on average, compared with 47 per cent of the non-family firms’ capital4.
"Our results show that during good economic times, family-run companies don’t earn as much money as companies with a more dispersed ownership structure," they summarised. "But when the economy slumps, family firms far outshine their peers. And when we looked across business cycles from 1997 to 2009, we found that the average long-term financial performance was higher for family businesses than for non-family businesses in every country we examined."
In Fielmann’s case, a strong business strategy and good management has enabled a company that is still largely family-owned to flourish.
However, as Simon Rowe, manager of the Henderson European Growth Fund points out, "While family ownership can help to align shareholders’ interests with those of management, this should not be seen as a determinant of success. Of far greater importance is the business strategy and how this is applied.
"For example, Fielmann, Germany’s largest spectacles retailer, was founded by Guenther Fielmann in 1972. Fielmann remains the CEO and the family foundation holds 70 per cent of the shares in a company that is valued at more than €5billion. The family’s presence on the shareholder register and the board is comforting, but the success of the business rests on its value-for-money proposition in which smart and inviting stores sell quality spectacles at affordable prices.
"Fielmann blends professional advice from competent opticians with a sense of fashion and because it directly produces its lenses and designs spectacles frames they produce stylish designs at a fraction of the branded competition. This has enabled the company to establish a virtuous circle of quality, price competitiveness and scale."
In Fielmann’s case, a strong business strategy and good management has enabled a company that is still largely family-owned to flourish. This combination has stood the test of time and provides a compelling case for looking at family-owned businesses.
- Source: Wall St Journal, "Trump Hotels Files Chapter 11; Donald Trump's Stake Will Drop" 23 Nov 2004
- Source: Banca March and IE Business School; "Value creation in listed European family firms 2001 - 2010"
- Source: Wharton Faculty Platform, Financial Management, "Family Control of Firms and Industries", Belén Villalonga and Raphael Amit, 2010
- Source: bcg.perspectives, “What you can learn from Family Business”, 18 Dec 2012
Graphic: Why do family-controlled public companies outperform?
UBS has devised a scoring system to cover areas of governance in family run businesses. It found that disciplined governance was crucial. Here, UBS has identified six key areas of critical importance in the way family businesses are run, and provided some key indicators investors should look for. Here is a summary5
Source: UBS, “Why do Family-Controlled Public Companies Outperform?, 13 Apr 2015. Past performance is not a guide to future performance